Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.

Unless the context clearly suggests otherwise, references to "the Company",
"we", "our", and "us" in the remainder of this report are to Shore Bancshares,
Inc. and its consolidated subsidiaries.

Forward-Looking Information

Portions of this Quarterly Report on Form 10-Q contain forward-looking
statements within the meaning of The Private Securities Litigation Reform Act of
1995. Statements that are not historical in nature, including statements that
include the words "anticipate", "estimate", "should", "expect", "believe",
"intend", and similar expressions, are expressions about our confidence,
policies, and strategies, the adequacy of capital levels, and liquidity and are
not guarantees of future performance. Such forward-looking statements involve
certain risks and uncertainties, including economic conditions, competition in
the geographic and business areas in which we operate, inflation, fluctuations
in interest rates, legislation, and governmental regulation. These risks and
uncertainties are described in detail in the section of the periodic reports
that Shore Bancshares, Inc. files with the Securities and Exchange Commission
(the "SEC") entitled "Risk Factors" (see Item 1A of Part II of this report).
Actual results may differ materially from such forward-looking statements, and
we assume no obligation to update forward-looking statements at any time except
as required by law.

Introduction

The following discussion and analysis is intended as a review of significant
factors affecting the Company's financial condition and results of operations
for the periods indicated. This discussion and analysis should be read in
conjunction with the unaudited consolidated financial statements and related
notes presented elsewhere in this report, as well as the audited consolidated
financial statements and related notes included in the Annual Report of Shore
Bancshares, Inc. on Form 10-K for the year ended December 31, 2011.

Shore Bancshares, Inc. is the largest independent financial holding company
located on the Eastern Shore of Maryland. It is the parent company of The Talbot
Bank of Easton, Maryland located in Easton, Maryland ("Talbot Bank") and CNB
located in Centreville, Maryland (together with Talbot Bank, the "Banks"). Until
January 1, 2011, the Company also served as the parent company to The Felton
Bank located in Felton, Delaware. On January 1, 2011, The Felton Bank merged
into CNB, with CNB as the surviving bank. The Banks operate 18 full service
branches in Kent County, Queen Anne's County, Talbot County, Caroline County and
Dorchester County in Maryland and Kent County, Delaware. The Company engages in
the insurance business through three insurance producer firms, The Avon-Dixon
Agency, LLC, Elliott Wilson Insurance, LLC and Jack Martin Associates, Inc.; a
wholesale insurance company, TSGIA, Inc.; and two insurance premium finance
companies, Mubell Finance, LLC and ESFS, Inc. (all of the foregoing are
collectively referred to as the "Insurance Subsidiary"). Each of these entities
is a wholly-owned subsidiary of Shore Bancshares, Inc. The Company engages in
the mortgage brokerage business under the name "Wye Mortgage Group" through a
minority series investment in an unrelated Delaware limited liability company.

The shares of common stock of Shore Bancshares, Inc. are listed on the NASDAQ
Global Select Market under the symbol "SHBI".

Shore Bancshares, Inc. maintains an Internet site at www.shbi.com on which it
makes available free of charge its Annual Report on Form 10-K, Quarterly Reports
on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing
as soon as reasonably practicable after these reports are electronically filed
with, or furnished to, the SEC.

Critical Accounting Policies

Our financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America ("GAAP"). The financial
information contained within the financial statements is, to a significant
extent, financial information contained that is based on measures of the
financial effects of transactions and events that have already occurred. A
variety of factors could affect the ultimate value that is obtained either when
earning income, recognizing an expense, recovering an asset or relieving a
liability.

Allowance for Credit Losses

The allowance for credit losses is an estimate of the losses that may be
sustained in the loan portfolio. The allowance is based on two basic principles
of accounting: (i) Topic 450, "Contingencies", of the Financial Accounting
Standards Board's Accounting Standards Codification ("ASC"), which requires that
losses be accrued when they are probable of occurring and estimable; and (ii)
ASC Topic 310, "Receivables", which requires that losses be accrued based on the
differences between the loan balance and the value of collateral, present value
of future cash flows or values that are observable in the secondary market.
Management uses many factors to estimate the inherent loss that may be present
in our loan portfolio, including economic conditions and trends, the value and
adequacy of collateral, the volume and mix of the loan portfolio, and our
internal loan processes. Actual losses could differ significantly from
management's estimates. In addition, GAAP itself may change from one previously
acceptable method to another. Although the economics of transactions would be
the same, the timing of events that would impact the transactions could change.

Three basic components comprise our allowance for credit losses: (i) a specific
allowance; (ii) a formula allowance; and (iii) a nonspecific allowance. Each
component is determined based on estimates that can and do change when the
actual events occur. The specific allowance is established against impaired
loans (i.e., nonaccrual loans and troubled debt restructurings) based on our
assessment of the losses that may be associated with the individual loans. The
specific allowance remains until charge-offs are made. An impaired loan may show
deficiencies in the borrower's overall financial condition, payment history,
support available from financial guarantors and/or the fair market value of
collateral. The formula allowance is used to estimate the loss on internally
risk-rated loans, exclusive of those identified as impaired. Loans are grouped
by type (construction, residential real estate, commercial real estate,
commercial or consumer). Each loan type is assigned an allowance factor based on
management's estimate of the risk, complexity and size of individual loans
within a particular category. Loans identified as special mention, substandard,
and doubtful are adversely rated. These loans are assigned higher allowance
factors than favorably rated loans due to management's concerns regarding
collectability or management's knowledge of particular elements regarding the
borrower. As seen in Note 4, "Loans and Allowance for Credit Losses", in the
Notes to Consolidated Financial Statements, special mention loans increased
$26.7 million from the end of 2011 to the end of the third quarter of 2012.
Approximately $6.6 million of these loans are expected to be upgraded by the end
of 2012. The nonspecific allowance captures losses that have impacted the
portfolio but have yet to be recognized in either the specific or formula
allowance.

Management has significant discretion in making the adjustments inherent in the
determination of the provision and allowance for credit losses, including in
connection with the valuation of collateral, the estimation of a borrower's
prospects of repayment, and the establishment of the allowance factors in the
formula allowance and unallocated allowance components of the allowance. The
establishment of allowance factors is a continuing exercise, based on
management's ongoing assessment of the totality of all factors, including, but
not limited to, delinquencies, loss history, trends in volume and terms of
loans, effects of changes in lending policy, the experience and depth of
management, national and local economic trends, concentrations of credit, the
quality of the loan review system and the effect of external factors such as
competition and regulatory requirements, and their impact on the portfolio.
Allowance factors may change from period to period, resulting in an increase or
decrease in the amount of the provision or allowance, based on the same volume
and classification of loans. Changes in allowance factors will have a direct
impact on the amount of the provision, and a corresponding effect on net income.
Errors in management's perception and assessment of these factors and their
impact on the portfolio could result in the allowance not being adequate to
cover losses in the portfolio, and may result in additional provisions or
charge-offs.

Goodwill and Other Intangible Assets

Goodwill represents the excess of the cost of an acquisition over the fair value
of the net assets acquired. Other intangible assets represent purchased assets
that also lack physical substance but can be distinguished from goodwill because
of contractual or other legal rights or because the asset is capable of being
sold or exchanged either on its own or in combination with a related contract,
asset or liability. Goodwill and other intangible assets with indefinite lives
are tested at least annually for impairment, usually during the third quarter,
or on an interim basis if circumstances dictate. Intangible assets that have
finite lives are amortized over their estimated useful lives and also are
subject to impairment testing.

Impairment testing requires that the fair value of each of the Company's
reporting units be compared to the carrying amount of its net assets, including
goodwill. The Company's reporting units were identified based on an analysis of
each of its individual operating segments. If the fair value of a reporting unit
is less than book value, an expense may be required to write down the related
goodwill or purchased intangibles to record an impairment loss.

During the third quarter of 2012, goodwill and other intangible assets were
subjected to the annual assessment for impairment. As a result of the
assessment, it was determined that there was no impairment at the Company's
subsidiaries that have these intangible assets on their balance sheets. During
the third quarter of 2011, when goodwill and other intangible assets were
assessed for impairment, it was determined that goodwill and other intangible
assets were impaired in our Insurance Products and Services segment, primarily
relating to the Company's retail insurance business. The Company recorded
goodwill impairment charges of $1.2 million and other intangible assets
impairment charges of $120 thousand reflected in noninterest expense.

Fair Value

The Company measures certain financial assets and liabilities at fair value.
Investment securities and interest rate caps are significant financial assets
measured at fair value on a recurring basis. Impaired loans and other real
estate owned are significant financial assets measured at fair value on a
nonrecurring basis. See Note 8, "Fair Value Measurements", in the Notes to
Consolidated Financial Statements for a further discussion of fair value.

OVERVIEW

The Company reported a net loss of $1.8 million for the third quarter of 2012,
or diluted loss per common share of $(0.22), compared to net income of $94
thousand, or diluted income per common share of $0.01, for the third quarter of
2011. For the second quarter of 2012, the Company reported net income of $293
thousand, or diluted income per common share of $0.03. When comparing the third
quarter of 2012 to the third quarter of 2011, the main reasons for the
difference in results were an increase in the provision for credit losses of
$2.6 million and a decline in net interest income of $1.4 million. When
comparing the third quarter of 2012 to the second quarter of 2012, the primary
reason for the difference in results was an increase in the provision for credit
losses of $2.7 million. Annualized return on average assets was (0.61)% for the
three months ended September 30, 2012, compared to 0.03% for the same period in
2011. Annualized return on average stockholders' equity was (6.07)% for the
third quarter of 2012, compared to 0.31% for the third quarter of 2011. For the
second quarter of 2012, annualized return on average assets was 0.10% and return
on average equity was 0.99%.

For the first nine months of 2012, the Company reported a net loss of $4.6
million, or diluted loss per common share of $(0.54), compared to a net loss of
$1.2 million, or diluted loss per common share of $(0.14), for the first nine
months of 2011. When comparing the first nine months of 2012 to the first nine
months of 2011, the principal factors driving the difference were an increase in
the provision for credit losses of $2.7 million and a decline in net interest
income of $3.0 million. Annualized return on average assets was (0.52)% for the
nine months ended September 30, 2012, compared to (0.14)% for the same period in
2011. Annualized return on average stockholders' equity was (5.08)% for the
first nine months of 2012, compared to (1.34)% for the first nine months of
2011.

RESULTS OF OPERATIONS

Net Interest Income

Tax-equivalent net interest income is net interest income adjusted for the
tax-favored status of income from certain loans and investments. As shown in the
table below, tax-equivalent net interest income for the third quarter of 2012
was $8.8 million, compared to $10.2 million for the third quarter of 2011. The
decrease was primarily due to lower yields earned on average earning assets and
a decline in higher-yielding average loan balances. Net interest margin is
tax-equivalent net interest income (annualized) divided by average earning
assets. Our net interest margin was 3.15% for the third quarter of 2012 and
3.77% for the third quarter of 2011. Loan charge-offs continued to negatively
impact our net interest income and net interest margin. For the second quarter
of 2012, tax-equivalent net interest income was $9.1 million and the net
interest margin was 3.36%.

On a tax-equivalent basis, interest income was $11.4 million for the third
quarter of 2012, declining from the $12.9 million recorded for the third quarter
of 2011. The decrease in interest income was due to a 69 basis point decline in
yields earned on average earning assets (i.e., loans, investment securities,
federal funds sold and interest-bearing deposits with other banks) that was
partially offset by a 3.6% increase in average balances of earning assets.
Changes in the balances and rates related to loans had the largest impact on
interest income. For the third quarter of 2012, average loans decreased 7.0% and
the yield earned on loans decreased from 5.49% to 5.23% when compared to the
third quarter of 2011, which reduced interest income by $1.4 million. Loans
comprised 72.9% of total average earning assets for the third quarter of 2012,
compared to 81.2% for the third quarter of 2011. Taxable investment securities
grew $25.8 million, or 23.5%, when comparing the third quarter of 2012 with the
third quarter of 2011, although yields declined from 2.88% to 2.01%, which
reduced interest income $110 thousand. The yields on taxable investment
securities decreased because the reinvestment rates on investment securities
purchased during 2012 were lower than the yields on the investment securities
that matured during the period. Partially offsetting the decrease in interest
income from loans and taxable investment securities was a $79.6 million increase
in the average balance of interest-bearing deposits and a 5 basis point increase
in rates earned on these assets, which increased interest income $50 thousand.
The increase in the average balance of interest-bearing deposits reflected
higher levels of excess cash to be invested. Tax-equivalent interest income
decreased 2.6% when compared to the second quarter of 2012. Average earning
assets increased 2.0% during the third quarter of 2012 when compared to the
second quarter of 2012, while yields earned declined 25 basis points.

Interest expense decreased $82 thousand, or 3.0%, when comparing the third
quarter of 2012 to the third quarter of 2011. The decrease in interest expense
was due to a 7 basis point decline in rates paid on interest-bearing liabilities
(i.e., deposits and borrowings) that was partially offset by a 3.4% increase in
average balances of interest-bearing liabilities. Changes in the balances and
rates related to time deposits (i.e., certificates of deposit $100,000 or more
and other time deposits) had the largest impact on interest expense. For the
three months ended September 30, 2012, the average balances of certificates of
deposit $100,000 or more and other time deposits each increased over 1.0% when
compared to the same period last year, while the average rates paid on these
time deposits decreased 17 and 25 basis points, respectively, which reduced
interest expense by $211 thousand. The decline in rates on time deposits
reflected current market conditions. Partially offsetting the decrease in
interest expense from time deposits was a 4.5% increase in the average balance
of money market and savings deposits and a 16 basis point increase in rates paid
on these deposits, which increased interest expense $142 thousand. Interest on
money market and savings deposits included an adjustment to expense related to
interest rate caps and the hedged deposits associated with them. This adjustment
increased interest expense by $524 thousand for the third quarter of 2012 and
$348 thousand for the third quarter of 2011. See Note 9, "Derivative Instruments
and Hedging Activities", in the Notes to Consolidated Financial Statements for
additional information. When comparing the third quarter of 2012 to the second
quarter of 2012, interest expense stayed relatively unchanged with average
balances of total interest-bearing liabilities increasing 1.9% and the interest
rate paid on interest-bearing liabilities declining 3 basis points.

The following table presents the distribution of the average consolidated
balance sheets, interest income/expense, and annualized yields earned and rates
paid for the three months ended September 30, 2012 and 2011.

(1) All amounts are reported on a tax-equivalent basis computed using the
statutory federal income tax rate of 34.0% for 2012 and 2011 exclusive of the
alternative minimum tax rate and nondeductible interest expense.

(2) Average loan balances include nonaccrual loans.

(3) Interest income on loans includes amortized loan fees, net of costs, and all
are included in the yield calculations.

(4) Interest on money market and savings deposits includes an adjustment to
expense related to interest rate caps and the hedged deposits associated with
them. This adjustment increased interest expense by $524 thousand for the
third quarter of 2012 and $348 thousand for the third quarter of 2011.

Tax-equivalent net interest income for the nine months ended September 30, 2012
was $27.1 million, as seen in the table below. This was a decrease of 10.0% when
compared to the same period last year. As with the quarterly results, the
decrease was mainly due to lower yields earned on average earning assets and a
decline in higher-yielding average loan balances. The net interest margin was
3.31% for the first nine months of 2012 and 3.79% for the first nine months of
2011.

On a tax-equivalent basis, interest income was $35.1 million for the first nine
months of 2012, a decrease of 8.9% when compared to the first nine months of
2011. The decrease in interest income was due to a decline of 56 basis points in
yields earned on average earning assets that was partially offset by an increase
of 3.0% in average balances of earning assets. When comparing the nine-month
period ended September 30, 2012 to the same period of last year, the 6.9%
decrease in average loans and the 16 basis point decrease in yields earned on
average loans was the primary reason for the decline in interest income. Loans
comprised 74.8% and 82.8% of total average earning assets for the first nine
months of 2012 and 2011, respectively.

Interest expense was $8.0 million for the nine months ended September 30, 2012,
a decrease of 4.9% when compared to the same period last year. The decrease in
interest expense was due to a decline of 10 basis points in rates paid on
average interest-bearing liabilities that was partially offset by an increase of
2.8% in average balances of interest-bearing liabilities. For the nine months
ended September 30, 2012, the 1.6% decrease in average time deposits and the 23
basis point decrease in rates paid on average time deposits were the primary
reasons for the decline in interest expense when compared to the same period
last year. Partially offsetting the decrease in interest expense from time
deposits was higher interest expense relating to a 5.7% increase in the average
balance of money market and savings deposits and a 19 basis point increase in
rates paid on these deposits

The following table presents the distribution of the average consolidated
balance sheets, interest income/expense, and annualized yields earned and rates
paid for the nine months ended September 30, 2012 and 2011.